Epitaph for the Corporate Income Tax

All those recent headlines about more U.S. companies contorting themselves to move their legal headquarters to Ireland or Britain could serve as an epitaph for the 105-year-old U.S. corporate income tax.

No, lawmakers in Congress aren’t about to repeal the tax. They say they don’t want to do modest tinkering with the tax code so they can save the energy (and, in some cases, the revenues) for that bigger, broader tax reform. But in the same breath members of Congress say doing bigger, broader tax reform is impossible in today’s polarized Congress.

So nothing happens. In Congress, that is.

U.S. corporations, though, aren’t waiting. Moving a headquarters abroad or buying a foreign firm to the same end (known as “inversion”) once was startling, or considered mildly unpatriotic. Today, as one chief financial offer told to me recently, executives and boards of many public companies think they have a fiduciary responsibility to shareholders to consider the move.

“I think we are going to see more of them with the current, very complicated tax system that we have,” Deputy Treasury Secretary Sarah Raskin said at a recent Wall Street Journal conference.

Why now? There are a few reasons.

(1) Although too much is sometimes made of the lofty 35% U.S. statutory corporate tax rate (because many corporations pay less, thanks to all the deductions, credits and loopholes), many other developed countries tax corporations less than the U.S. does. That’s why so many U.S. firms are looking for ways to turn themselves into non-U.S. companies. And some that don’t do that maneuver may end up selling parts of themselves to foreign companies or losing bidding wars to foreign companies because those based abroad can pay more because they pay less in taxes. The U.K. has cut its rate to 21%. (See an OECD comparison here.)

(2) Big multinational companies excel at exploiting competition among countries to make themselves more attractive to corporations. As the International Monetary Fund put it in a new staff paper: “The relatively low amounts of tax that, as a result of cross-border tax planning, many multinational enterprises pay has given rise to significant public disquiet.” The IMF says it’s a bigger issue in many poorer countries than in the U.S. because a bigger share of their revenues come from corporate taxes.

(3) Taxing corporations as a way to tax owners of capital was easier when companies and their shareholders tended to be mostly in one country. It doesn’t work as well in an era of big companies with businesses and assets and shareholders on every continent (even though the bulk of shares of U.S. firms are still held by U.S. residents.) “Current international tax arrangements rest on concepts of companies’ ‘residence’ and the ‘source’ of their income, both of which globalization has made increasingly fragile (some would say meaningless),” the IMF staff said.

The U.S. is trying to maintain a corporate tax system that isn’t compatible with those in the rest of the world. “Congress and other decision-makers haven’t internalized how important globalization is to the tax system,” says Michael Graetz, a tax law professor at Columbia University and a U.S. Treasury official in the George H.W. Bush administration. Edward Kleinbard, a former congressional tax aide now at the University of Southern California law school, says clever multinationals have created “stateless income,” profits that are taxed (lightly if at all) in jurisdictions other than their home base or the places where they actually operate, and this gives them an edge over largely domestic companies.

The U.S. corporate income tax has few remaining defenders. Corporations say it’s excessively complex and counter-productive. The left says that it is so riddled with holes that only dumb companies pay the statutory rate; it wants to plug the holes, which seems to be a losing battle. The right says corporations shouldn’t be taxed at all; that won’t fly politically. Economists deem the current corporate tax code inefficient, and they’re right. At least one member of Congress a day condemns it; agreement on how to change or what to replace it with is, well, elusive.

As Eric Toder of the Tax Policy Center and Alan Viard of the American Enterprise Institute put it recently, the most talked about tweaks to the corporate tax code “fail to resolve the fundamental contradictions.”

They propose two alternatives: An international pact to decide how to allocate multinationals’ profits or replacing the corporate income tax with a shareholder tax on dividends and unrealized capital gains. Many big companies argue for what’s called a “territorial” system, where countries tax only profits earned inside their borders. Mr. Kleinbard argues that would require tougher global anti-abuse rules than are politically plausible; he’d tax U.S. corporations’ global profits but at a lower rate so they’ve got less reason to shift profits abroad.

After an earlier round of corporate expatriation (Ingersoll-Rand, Fruit of the Loom, etc.), Congress thought it had solved the problem by changing the tax law. Wrong. Pfizer didn’t, in the end, do the deal to turn itself into a British company. But without some change in law, a big brand-name company is going to make the move and become the poster child for either a narrow change to make inversions harder or a bigger tax reform. New Senate Finance Chairman Ron Wyden is on the case.

Here’s the bottom line: Either we are going to tax income at the corporate level in ways that make the U.S. a place where companies want to have headquarters, invest and create jobs. Or we should give up and find a better way to raise revenue on the owners of capital. If we don’t, we’ll be watching other made-in-America companies join the expatriate parade and the corporate income tax and the revenue it produces will wither away.